New Jersey Supreme Court Holds That First Mortgagee May Lose Priority On Optional Future Advances Made After Notice of an Intervening Lien
The New Jersey Supreme Court has held that optional advances under a loan
agreement are subordinate to a junior lienholder when made after the lender receives
actual notice of the intervening lien. The case, Rosenthal & Rosenthal v. Benun, et. al.,
pitted Rosenthal & Rosenthal, Inc., a factoring company and holder of two senior
mortgages which allowed optional future advances against Riker, Danzig, Scherer,
Hyland & Perretti, L.L.P., a law firm which took a subordinate mortgage to secure the
payment of its legal fees.
Rosenthal & Rosenthal, Inc. (The First Mortgagee) held two mortgages on certain real
property in New Jersey. The mortgages secured loans made to a group of businesses
known as the Jazz Entities. The loans secured by the mortgages provided that
Rosenthal had the option to make future advances to the Jazz Entities up to a maximum
principal of one million dollars. Later, the Jazz Entities became indebted to the law firm
of Riker, Danzig, Scherer, Hyland & Perretti, L.L.P. (Riker) in the amount of $1.67
million in unpaid legal fees. In exchange for the firm’s agreement to continue to provide
legal services, the Jazz Entities gave a mortgage to Riker on the property secured by
the Rosenthal mortgages. Riker continued to perform legal services, and its unpaid fees
eventually grew to $3 million. Then, in connection with a contemplated new loan,
Rosenthal became aware of Riker’s mortgage and sent an e-mail to the firm stating that
Riker’s mortgage would need to be subordinated to any new mortgage made by
Notwithstanding its knowledge of the junior mortgage, Rosenthal continued to make
advances pursuant to the original loan. Eventually, the borrowers defaulted on both the
Rosenthal and Riker loans. Rosenthal instituted foreclosure proceedings, and Riker filed
a contesting answer asserting priority over the advances made after Rosenthal had
received notice of Riker’s mortgage. The determination of priority was critical to both
parties, as the total indebtedness far exceeded the value of the mortgaged property.
The New Jersey Supreme Court began its analysis of the case with the common law
rule, which states that where future advances are optional, the first mortgagee retains
priority only for advances made before receiving notice (usually actual notice) of a junior
lien. This rule is in contrast to the rule which applies to agreements in which future
advances are mandatory. In such agreements, future advances retain the priority
position of the original mortgage. In addition to the common law rule, the Court
considered New Jersey’s mortgage priority statute, which protects the priority of loans
that are later modified. However, the statute expressly excludes from the definition of
modification an advance of principal. Therefore, advances made after the origination of
a loan fall under the common law rule.
The Court held that, where optional future advances are made after actual notice of an
intervening lien, the advances made after such notice are junior to the intervening lien.
Some lending industry members have expressed concern over the implications of the
Court’s holding. In an amicus brief, the New Jersey Bankers Association (NJBA) argued
that allowing future advances to be subordinate to intervening liens could have three
negative impacts on lenders. First, they argue that lenders may avoid future advance
transactions because of the risk that intervening liens may destroy their priority position.
Second, they argue that lenders may avoid checking title before making advances in
order to avoid receiving notice of intervening liens (as only liens of which the lender has
actual notice take priority over subsequent advances). Third, they argue that the need to
negotiate subordination agreements with intervening lenders would leave lenders
unable to timely meet the changing capital needs of their commercial borrowers. The
NJBA argued that the burden of these considerations is more properly placed on the
intervening lender, who is a newcomer to the existing contractual relationship. The
Court acknowledged that these concerns may be valid and pointed out that some
jurisdictions have passed statutes to protect the priority of future advances made after
notice of an intervening lien. However, the Court found that such policy concerns are
best addressed by the legislature.
Lenders are advised to consult the law of their jurisdiction before entering into loan
agreements which provide for optional future advances. Before making advances
pursuant to such an agreement, lenders should determine whether they have received
notice of a junior lien on the property secured by the mortgage. Lenders should also be
aware of situations –such as construction loans in New Jersey—under which future
advances lose priority to a junior lien of which the lender has merely record notice,
rather than actual notice. Finally, in response to the concerns raised by the lending
industry, the Supreme Court stated that such concerns are best addressed by
legislation. Our firm will continue to monitor this issue for legislation which may alter the
rule announced by the Supreme Court.
Stern & Eisenberg, PC is a regional law firm that provides an array of services to
institutional lenders and private clients alike. To the extent we may assist you in
navigating or understanding this case specifically or the New Jersey foreclosure
process generally, please contact Steven Eisenberg at firstname.lastname@example.org
or Lucas Anderson at email@example.com at your convenience.
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